Bitcoin, to bit or not to bit?

bitcoinAs we turn the calendar to a new year, let’s take a look at what’s new in the financial world – Bitcoin. Bitcoin has been around for a bit and it continues to garner attention and headlines and probably will continue to do so in the future. This is a look at what Bitcoin is, how it works and whether or not you should put your own money into it.

So, what is a Bitcoin? Bitcoin is a global cryptocurrency and digital payment platform. It has been recognized as the first decentralized digital currency, since the system works without a central bank or government. It was invented by an unknown programmer, or a group of programmers, under the name Satoshi Nakamoto and released as open source software in 2009 via a white paper. The system allows for peer to peer, peer to business or business to business transactions to take place between users directly, without an intermediary. These transactions are verified by networks of computers and recorded in a public online ledger called the blockchain.

Money is a social construct to make trade and economy more efficient.When looking at a currency or something posing as a currency, there are several things that you need to consider including whether or not the currency meets these three simple principles:

  1. Medium of exchange – be able to easily facilitate trade
  2. Needs to hold its value and store of wealth
  3. A dependable form of account

At first glance, Bitcoin is doing those three things.  It is the weakest at dependability as the price moves around wildly and many have had their bitcoins stolen through scams and hacking. If the money or currency does those three things, you must then see if it has the five attributes of currency or money:

  • Scarcity
  • Portability
  • Recognizability
  • Divisibility
  • Durability

Bitcoin has a hard-coded encrypted algorithm built into it that creates new Bitcoins. That, at first glance, does make it scarce. We know how many there are and when they were created. Conversely, looking at the US dollar, the Federal Reserve stopped publishing how and when they create money. So, we actually have no idea how many US Dollars are being created and when. So, from a transparency standpoint, Bitcoin looks more appealing. But is it scarce?

Looking at just Bitcoin alone, yes, it is scarce and as time goes by, fewer and fewer Bitcoins will be created per year, per month, per day. The problem with the scarcity test is that there are now over 6,000 different cryptocurrencies copying Bitcoin’s path. When looking at the industry as a whole, it is now not so scarce.

Regarding portability, Bitcoin does pass the test. You can carry them on your phone in an online account. You can download them to a thumb drive that is off the grid, so they are more secure. You can even convert them to a printable certificate. You can use Bitcoin in almost every corner of the world, so yes they are portable.

Recognizability is another test Bitcoin passes. Now that they are eight years in and nearing $5,000 a coin, more and more people, businesses and governments are recognizing them.

Another advantage of Bitcoin is divisibility. You can purchase Bitcoin in fractions of a coin going out eight decimal places. So, even if the price were to continue to appreciate towards $10,000 a coin, the divisibility of it is inherently easy and built in.

Durability is an interesting one. Many people have had Bitcoins stolen over the last eight years as it sits on the internet. That is fixing itself as technology, progress and more big money comes to the table. Further, the US government and other governments around the world are rushing in to regulate, tax and control more of Bitcoin to protect investors.

Despite seeming to pass all these attributes, Bitcoin is not without problems. Let’s say you buy some Bitcoins and leave them on your computer and you pass away. You never told anyone the password so, what happens to them? If you were to invest in a stock, let’s say a brokerage firm would have a record of your assets and be able to contact your beneficiaries. Not with Bitcoin.  Unless someone knows your password, your Bitcoins are lost.

The durability of Bitcoin also has some risk given the fact that many people have had their Bitcoins lost or stolen and there is always the potential for the internet to go down. Since anyone can ‘mine’ for Bitcoins, the more people mine, the more the network is diversified and protected. Bitcoin really lives on the internet and is replicated by private citizens and entities that further ensure the networks accuracy and stability.

With all of that in mind, in terms of putting your money into Bitcoin, we recommend treading lightly. It is only eight years old, we’re still talking about the ins and outs of it and the price has risen dramatically. So, the long-term viability is still working itself out.

In addition, we have seen the US government try to step in to tax and control the transactions of Bitcoin. Exchanges that have been created to help others transact in Bitcoin are now likely to be pulled into regulation by the government and will be made to adhere to rules similar to what stock market-based brokerages must do. Brokerages must have customer rules in place, track capital gains and losses and issue 1099’s at the end of the year for tax reporting. With all that being said, the regulations will allow larger corporations and Wall Street to get involved which could help bring more volume and stability to Bitcoin over time.

Are there any large institutions involved in cryptocurrencies?

According to Reuters, the Enterprise Ethereum Alliance (EEA) will work to “enhance the privacy, security, and scalability of the Ethereum blockchain, making it better suited to business applications”, according to the founding companies. Members of the 30-strong group include Accenture Plc, Banco Santander, BP Plc, Credit Suisse Group AG, UBS Group AG, Banco Bilbao Vizcaya Argentaria, ING Groep NV, Bank of New York Mellon Corp, Thomson Reuters Corp and startups ConsenSys and BlockApps. Those are some big names.

So, where can you spend your Bitcoin? Among others, you can spend Bitcoin at:

  • Microsoft
  • Virgin
  • Galactic
  • Tesla

Those are some pretty big names and with just that handful,  you could furnish your whole house, put a car in the driveway and take a trip to outer space.

Bitcoin and the blockchain are compelling and many are saying that Bitcoin will eventually replace gold while others say Bitcoin is a Ponzi scheme. Only time will tell if Bitcoin, the blockchain and the technological opportunities from the tech itself will continue to grow as more and more companies invest in it. Bitcoin is real and to me is a real currency because people are transacting in it, but will it replace gold? No. Gold has stood for over 5,000 years and survived the Roman Empire, the Ottoman Empire, the dynasties in the East, the Euro, the dollar, sundials, tulips, grain, cattle and everything in between that has acted as currency over the past 5,000 years.

Will Bitcoin become completely worthless? I don’t think so either. The interest in both gold and Bitcoin is coming from the same place. People want to be free to organize their capital, protect their purchasing power and truly transact business globally without all the government and banking red tape. People are clamoring for sound money and a currency that is based on something of value, such as the value of the blockchain and the idealism of the purity of an algorithm showing how the currency will be created.

What we do know is that all major countries around the world, that you would potentially feel comfortable holding their currency, are supported and controlled by a private central bank. That central bank does not have to publish the money supply, is not truly owned by the government and thus the people and that money are not backed by anything more than the faith of the people in that system.

Since the United States went off the gold standard in 1971, the price of gold has appreciated in dollar terms. Since Bitcoin was established in 2009, the price has appreciated dramatically. There are millions of people voting with their money globally for currencies that are more transparent, backed by assets and have the ability to transact across borders with less regulation. Gold, precious metals and cryptocurrencies like Bitcoin fit those desires.

I think the hardest part about understanding Bitcoin is the fact that we are Americans and our currency has been relatively stable for a long time and with the exception of inflation, the US dollar and our economy have been relatively predictable.

But, in many countries around the world that is not the case. Look at the turmoil in Syria right now and the instability in Afghanistan. Venezuela has had two currency crashes in the last 20 years alone while the banks and government in Cyprus colluded to confiscate 10% of all bank deposits.

Furthermore, many people in America are working here and transmitting money back home to loved ones. Bitcoin facilitates that so much easier than banks and/or Western Union. It’s instant and with fewer fees. As Uber and Airbnb have upended the taxi and hospitality industries respectively and as more and more people do business peer to peer, it is no wonder that money would change as well and Bitcoin is facilitating that.

Only time will tell whether an ounce of gold or a Bitcoin will be worth more.